ESG-Themed Investments: What Are They And How Are They Managed?

Mee-Hyoe Koo
, ContributorI cover CSR, social entrepreneurship and impact investing in Asia.Opinions expressed by Forbes Contributors are their own.

What is sustainable investing? Often understood as the incorporation of environmental, social and governance (ESG) analysis into investment decision-making, this is a now growing niche in the world of investment as the asset owners and managers are looking for opportunities for long-term value creation for investors and society.

Recently, there has been an increasing number of industry leaders across the globe that have supported the idea that key ESG developments can have significant trans-formative impact on the society in general.

To better understand the reality of sustainable investing and the decision-making process that are involved in ESG-themed investments, Forbes Asia interviewed Anthony L.T. Cragg, the managing director and senior portfolio manager of Wells Capital Management, a wholly owned subsidiary of Wells Fargo and Company.

FORBES ASIA: What is the current trend in impact investing in Asia-Pacific?

CRAGG: Unlike other venture or private equity funds, our strategy is to invest in public-traded (not private) Emerging Market companies with at least $200 million in market capitalization or more. Only about a quarter of the fund is in companies with less than $2 billion in market cap. We invest in all sectors across all emerging market countries, where we see opportunities except fossil fuel-related sectors (e.g. oil companies) and a couple of other areas. Our investments are driven by five ESG themes rather than sectors.

Our focus – and how we view trends - varies by country. In China, there’s tremendous growth opportunity in clean and efficient energy technologies. In Brazil and South Africa, we see especially strong growth in social equity themes. For instance, like affordable housing and access to financial & consumer services. One theme, which is a focus across our regions, is improving access to healthcare and medicine.

FORBES ASIA: Do you think that there would need to be a trade-off between impact and profit? Financial assessment goes hand-in-hand with impact when making investment decisions; do you think returns of approximately 20 percent could be not far from reality?

CRAGG: We don’t target a particular level of absolute return. Our aim is to outperform the MSCI Emerging Market benchmark over a full market cycle (3-5 years.). This goal is the same across all of the funds we manage.

So far our performance data shows that we can perform better than MSCI Emerging Market benchmark by running this strategy. As of June 30, 2013, our ESG fund outperformed on an year-to-date, one year- and since inception bases. (Inception date was March 31, 2012.) Our belief is that the integration of ESG factors enhances our ability to analyze EM companies and helps us make more informed investment decisions – sometimes looking at the factors that other investors didn't notice.

FORBES ASIA: Nelson Capital Management is a leading investment manager with unique expertise in strategies incorporating Environmental, Social & Governance considerations into a consistent, disciplined investment process. It is a part of the Wells Fargo Asset Management Group; but it maintains autonomy and local responsibility for the investment process. Having said this, could you please walk me through the steps – from collaboration with Nelson Capital Management to tackling the challenges within the 5 thematic areas of opportunity selected by Wells Capital Management?

The WellsCap and Nelson teams work closely together to identify companies well-positioned to manage ESG risks and opportunities over the coming years, with a thematic focus on providers of sustainable solutions. We look for ESG-driven opportunities in companies providing solutions to environmental and social challenges in 5 thematic areas.

Each company in our EM ESG universe is given a score for its “ESG solutions intensity,” based primarily on the % of overall revenue derived from solutions-related business, but also considering growth and momentum of this business.

Next, each company is assessed for ESG management and is given scores for how it manages each of the 3 areas –environmental, social & governance - by Nelson Capital. This process involves fairly traditional ESG assessment, as we evaluate a wide set of ESG metrics (environmental management & impacts, climate change responsiveness, energy & water use, labor practices, community impact & involvement, human rights policies & practices, board composition & independence, ethics & governance policies) with a special emphasis on identifying particularly strong ESG management and outsized ESG-driven risks.

Companies assessed to have outsized ESG-driven risks are tagged with Risk Flags – these stocks are typically buy-able but are flagged for special monitoring, although in some cases the ESG risks are assessed to be too high for us to invest. Overall, our goal is to build an ESG-driven case for owning each stock, rather than emphasizing avoidance of certain business exposures. We do not invest in manufacturers of tobacco products, companies with strategic involvements with the government of Sudan, and companies with severe governance violations.